Rubén Cruz
Advisory Partner, Head of Energy and Natural Resources
KMPG in Mexico

Predictions for the Success of Final Phases

Wed, 01/20/2016 - 13:12

Over the past decades, PEMEX’s investments in exploration activities were low in comparison with industry standards, particularly in deepwater and unconventional resources, but Rubén Cruz, Advisory Partner, Head of Energy and Natural Resources at KPMG Mexico, firmly believes that the reform will reverse this trend. “Reserves replacement rates have been in the range of 65-70%, a situation that calls for urgent investment in upstream activities in order to, firstly, elevate reserves replacement rates above 100%, and secondly, eventually increase production,” he points out. In the past two years, production declined at a 5.1% average rate per annum. The implementation of the reform will partially reverse this situation with the entry of 30 new operators resulting from the first three phases of Round One, which have collectively committed investments of an estimated US$6.9 billion, meaning that, at peak production, these developments could add 280,000 boe/d, an increase of 12.5% on current levels. “The fourth phase that will take place later this year, the farm-outs, and the unconventionals rounds are critical for the discovery and development of new reservoirs that will increase production in the medium and long term,” Cruz asserts

Cruz identifies the third phase of Round One is the smoothest of all the rounds in term of implementation, as licenses do not have the complexity of other contracts, and the awarded onshore fields have proven reserves and infrastructure, which decreases the investment required. Of the US$6.9 billion expected to be invested in Round One, US$1.1 billion will be channeled into the blocks awarded in R1-L03. Regarding the possibility of new operators expanding to other areas, this could be done through partnerships with third parties, since a key limitation in the upstream segment is financial. “Typically banks do not provide financing for exploration activities, and only a few private equity funds find this kind of risk attractive,” he reports. Companies that won contracts in R1-L03 will gain experience as operators, but Cruz feels they will still lack the technology needed to exploit offshore fields, highlighting the importance of partnerships in expanding to other segments.

KPMG helps clients handle risks entailed in financial aspects, while also helping with anti-bribery and corruption affairs, financial reporting best practices, audit services, and the development of strategies so that companies can form strategic alliances with third parties or grow through M&As. “A key feature of our services is the fact that we assist players in participating in bidding rounds, and among some of our new clients are those companies that won contracts,” shares Cruz.

He anticipates that the most significant risk companies will face in the upstream segment will lie in exploration activities. Another significant challenge will be accountability in terms of environmental compliance and malfunctions in facilities or equipment, he explains. “Moreover, companies are concerned about the administrative recession stated in the contracts and also about corporate guarantees, and I believe that it is highly unlikely that the majors’ holding companies will feel comfortable with these types of guarantees,” Cruz asserts. Instead, he predicts that the risks will ultimately be transferred to a certain degree to companies that provide services to these large players, and they will have to find ways to mitigate these risks.

Cruz believes that the implementation of the Energy Reform has been carried out in an impressively short timeframe and compares it to NAFTA due to the scope of changes it will bring about in the market, and the long term results. The results of NAFTA are now tangible and positive, but if these had been measured two years after the treaty was enacted, he highlights, the results would not have been a fair reflection of its scope, as the country was in the midst of one of the worst economic crises in its modern history. “The Energy Reform and other parallel reforms impact different segments and industries simultaneously, so it entails a great deal of complexity regarding its implementation and regulations,” Cruz comments. In this sense, the main guidelines have been issued and the regulators have been closely following the developments in order to quickly cover any existing grey areas or demands required by the guidelines. “However, players have commented that even though the assignations are there, details on the implementation of the contracts and other operational aspects are still lacking,” he states. “The regulator’ challenge will be to react at the same pace as that at which the reform continues to unfold.”

In terms of the final phases of Round One, KPMG views the fourth phase of Round One in a positive light in spite of the current low oil price. “The contract model for the deepwater round was drafted in a realistic way by considering the developments of the exploration stages through real options, which brings increased security to investments,” Cruz comments. He believes that the fact that licenses were chosen also helps because this is the contract model majors are accustomed to working with in many markets. “Companies will seriously consider entering Mexico even if their budgets are cut because of the low oil price,” Cruz predicts. “Given the fact that Mexico is competing with other upstream markets, flexibility in the contracts and clarity regarding guarantees is important.”